Saturday, August 08, 2009

The Reserve Bank has broken with tradition and laid out aroad mapfor future interest rate rises indicating it expects to push up its cash rate from 3 per cent to nearer 5 per cent over the next two years.

Such an increase, which the Bank stresses "in no way constitutes a commitment by the Board" would add thousands of dollars to annual cost of servicing a typical mortgage.

Until now the Reserve Bank has prepared its economic forecasts using what it called a "technical assumption" of steady interest rates. But the quarterly forecasts released yesterday for the first time broke with the past and penciled in a specific path of rate hikes because, in the words of the Bank, "in the current environment it is not particularly realistic to assume the cash rate remains at its historically low level of 3 per cent."

The Bank has instead factored in a series of increases to "return the cash rate towards a more normal setting" by late 2011. Bank officials have previously described a normal setting as a cash rate at between 5.5 and 6 per cent.

Such a series of hikes would add $110 to the monthly cost of servicing a $100,000 mortgage...
...$331 to the cost of servicing a $300,000 mortgage and $662 to the cost of servicing a $600,000 mortgage.

The statement is at pains to point out that households and businesses should be easily able to afford such increases, describing mortgage rates as their lowest since 1964 and pointing out that most households pay far less than than the standard variable rate of 5.81 per cent, with discounts making the average rate charged 5.17 per cent.

Although risk margins charged to businesses have climbed, the Bank says the average rates charged to small and large businesses are still 2.30 and 3.35 points lower than they were before the financial crisis.

The Bank is forecasting a rapid return toward economic health next year and then a return to normal growth the following year after growth averaging a little above zero for the rest of this year.

The new 2009 forecast is a big improvement on the Bank's previous forecast released ahead of the May Budget that had the economy sliding 1 per cent. The 2010 forecast has the economy growing at 2.25 per cent, up from 2 per cent.

The faster recovery stands to boost tax collections by around $6 billion, knocking down the forecast budget deficit from $57.6 billion to around $52 and cutting projected government debt.

Treasurer Wayne Swan said he was "encouraged" by the Bank's assessment and that the Treasury itself would be revising up its forecasts in the Budget update to be released later this year.

He said now was not the time to wind back the government's stimulus programs and that the Reserve Bank's forecasts were "predicated on the full implementation of economic stimulus".

The Bank warns consumer spending is likely to slow as the boost from the bonus payments fades but says home-building is set to pick up along with "stimulus-related expenditure on schools, home insulation and public infrastructure".

It says Australia’s exposure to "China, India and elsewhere in Asia" will stand it in good stead and notes that Chinese steel production has jumped 20 per cent since the end of last year, boosting demand for Australia's iron ore and coking coal.

While not revealing its unemployment forecast the Bank points to indicators that "the pace of deterioration is easing" and says the unemployment rate should rise by less than it had expected.